August 13mgmt127b

August 13mgmt127b - Shareholder $ STOCK Cor poration W H 40...

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Unformatted text preview: Shareholder $ STOCK Cor poration W H 40 shares 60 shares Cor poration 5% H H Co. 20 Shares X Co. Seagrams 24% DuPont UNI VERSAL August 13, 2008 MG MT 127B Stock Redemptions Money comes out when the shareholder sells the stock back to the company. On its face it would seem like a capital gain. However, that could create a loophole, especially if it was a one or two person company. If you are the sole owner of a company and you receive a dividend, it is ordinary income and taxed as such. What if you sold some of your stock back? You arent really changing your ownership. You are still 100% owner. Recognizing that fact, the sale of stock back to the company has no economic meaning, or at least possibly has no economic meaning. The general rule is that we view the money and property that comes out as a Section 301 distribution. If the company has earnings, the distribution is a dividend. The moving of paper has no economic meaning. I t is treated as one-directional. You keep your basis the same, or equivalently, the basis in the shares that you sold is moved to the shares that you still own. This plugs the loophole, but over plugs in the sense that legitimate sales, like when the founder of a company wants to retire, cannot get capital gain treatment. We now say that some sales are legitimate and should be treated as so. They should get capital gain or capital loss treatment. Exceptions For Sale or Exchange T reatment What distinguishes a legitimate sale of stock back to your company from one that is just a disguised dividend? One distinguishing factor is when your ownership percentage goes down. I t sounds like you have a t rue economic non-tax change. If you go for 78% to 22%, you have significantly changed your position. When there is a substantially disproportionate effect in your ownership, you will get sale or exchange treatment. When do we say this occurs? 1. When shareholders new ownership percentage is below 80% of their previous ownership percentage. If you became a 50% owner, as long as you lose 1/5 of 50%, or drop to 40%, it is viewed as material. Redemptions (pg. 49) You own 40 percentage points. Your basis is $6 per share You take 10 of your shares and sell them back for $97 General rule says income is $97. They are giving up 25% of their stock, so it looks like they meet the requirements for substantially disproportionate effect. However, we must focus on percentage points. The percentage points we now hold is 30/90 = 33.3 percentage points. You must lose 1/5. From 40 percentage points, you had to lose 8 and drop down to below 32 percentage points. 33.3% is not less than 32%....
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August 13mgmt127b - Shareholder $ STOCK Cor poration W H 40...

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